Tax Court Denies Deduction for Medical Expenses Paid Via Insurance Settlement
Double-dipping is more than just a faux pas committed by fat toddlers at Super Bowl parties; it’s also an undeserved tax benefit that much of the language in the Code is designed to safeguard against. The prohibition on double-dipping is why taxpayers generally can’t take a tax deduction and credit on the same expense, or why an asset’s depreciable basis must be reduced by any first-year “bonus” depreciation. Or, in the case of Judith Gaerttner (Gaerttner), why she couldn’t take a medical expense deduction for amounts reimbursed by insurance.
In 2002, Gaerttner was involved in an automobile accident. She underwent treatment for her related injuries through 2004, but did not pay out-of-pocket for any of the medical expenses. Instead, she signed a waiver requesting that her doctors bill her attorney. In late 2004, Gaerttner received a $20,000 insurance settlement and ordered her attorney to pay $11,000 worth of accrued medical bills.
On her tax return, Gerttner excluded the $20,000 of settlement proceeds [i] from income and claimed $20,915 of medical expenses as itemized deductions on Schedule A. [ii]
The IRS audited Gaerttner’s tax return and disallowed half of her medical expenses. Gaerttner responded by arguing that the expenses were attributable to her 2002 automobile accident.
The Tax Court sided with the IRS anddisallowed themedical expenses.
In general, I.R.C. § 213(a) provides that expenses paid during the taxable year for medical care of the taxpayer, not compensated for by insurance or otherwise, shall be allowed as a deduction to the extent that such expenses exceed 7.5% of adjusted gross income. The regulations reinforce the language emphasized above, stating that in order for medical expenses to be deductible, the expenses must not be “compensated for by insurance or otherwise.”[iii] This made for an easy decision by the Tax Court:
Ms. Gaerttner was compensated by insurance for medical expenses related to her 2002 automobile accident. The record confirms that Ms. Gaerttner’s attorney paid her accumulated medical bills in 2004 when he received the insurance settlement
[i] The IRS had no issue with Gaerttner’s exclusion of the settlement proceeds, as settlement amounts paid on account of a physical personal injury are generally excluded from the taxpayer’s income under I.R.C. § 104(a)(2).
[ii] For whatever reason, Gaerttner actually deducted the medical expenses on her 2005 tax return, as opposed to the 2004 return, but it’s not germane to this discussion.
[iii] Treas. Reg. § 1.213-1(a)(3)(i).
